Swedroe: Past Performance Deceives

November 10, 2017

  • Plan sponsors hire investment managers after large, positive excess returns coming up to three years prior to hiring.
  • Such return-chasing behavior does not deliver positive excess returns thereafter.
  • Post-hiring, excess returns are indistinguishable from zero.
  • Plan sponsors terminate investment managers after underperformance, but the excess returns of these managers after being fired are frequently positive.
  • If plan sponsors had stayed with the fired investment managers, their returns would have been larger than those actually delivered by the newly hired managers.

It is important to note that the above results did not include any of the trading costs that would have accompanied transitioning a portfolio from one manager’s holdings to the holdings preferred by the new manager. The bottom line: All of the activity was counterproductive.

Another study of pension fund managers found the same results. T. Daniel Coggin and Charles Trzcinka, authors of the study “A Panel Study of U.S. Equity Pension Fund Manager Style Performance,” which was published in the Summer 2000 issue of the Journal of Investing examined the performance of 292 pension plans with 12 quarters of data up to the second quarter of 1993.

The following summarizes their findings:

  • It is very difficult to find investment managers who consistently add value relative to appropriate benchmarks.
  • There was no correlation found between relative performance in one period and future periods.
  • There was no evidence the number of managers who beat their benchmarks was greater than that attributable to pure chance.

The authors concluded: “Those who rely solely on historical style alphas to predict future style alphas are likely to be disappointed.”


There’s an axiom in finance that when the evidence conflicts with the theory, no matter how logical and intuitive it may be, throw out the theory.

Unfortunately, most investors continue to ignore the evidence that makes it clear a policy of hiring recently outperforming managers and firing recently underperforming managers is a losing strategy—one that can even be said to be 180 degrees wrong.

The results you have seen in the research pose a significant challenge for plan sponsors and investors in general who continue to base decisions on beliefs that run counter to the evidence.

The bottom line is that, in general, plan sponsors and other investors are doing the same thing over and over again and expecting a different outcome.

Most seem to never stop and ask the question: If the managers we hired based on their past outperformance have underperformed after being hired, why do we think the new managers we hire to replace them will outperform if we are using the very same criteria that has repeatedly failed? And, if we aren’t doing anything different, why should we expect a different outcome?

I’ve asked these very questions of many plan sponsors and never once received an answer—just blank stares.

The practical implication is that asset owners should change the criteria they use to select managers.

Instead of relying mainly, if not solely, on past performance, they should use criteria such as fund expenses and the fund’s amount of exposure to well-documented factors (e.g., size, value, momentum, profitability and quality) that have been shown to have provided premiums. These premiums should be: persistent, pervasive, robust to various definitions, implementable (they survive transaction costs) and have intuitive explanations for why they should persist.

A set of criteria like that will almost certainly lead investors to avoid actively managed funds and increase their likelihood of superior results.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.

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